Small Price Difference, Relatively Large Performance Difference

Aug 19, 2015

Different buyers mean different approaches, and price-sensitive customers need to be handled differently when pricing premium versions.

Last week a post looked at the differential pricing strategy used on the standard and premium versions of name brand rechargeable batteries. In this example the premium version cost much more (about 75% more) than the standard version, while offering a relatively small (29%) increase in performance. This is an example of differential pricing, where the vendor can place a much higher markup on a premium version that is more focussed on performance and less on price. It effectively lets them sell very a similar product at a much higher profit to customers that are ready and willing to pay more.

The post also looked at the pricing on premium and standard versions of rechargeable batteries from a generic "house" brand that targets more price-sensistive customers.

Here is the standard 1900mAh version of their rechargeable batteries, which sell for $18.99.

Here is the premium 2400mAh version, selling for $22.99:

The name brand vendor we looked at in the earlier post charges an extra $20 to go from 1900mAh to 2450mAh. The house brand charges just $4 more for almost the same difference in performance (1900mAh to 2400). It is an enormous difference, 500%, and assuming that the costs are similar it means an incredible markup for the brand name vendor.

Relative to the name brand, where you pay a huge premium for a relatively small increase in performance (75% more money for just 29% more performance) upgrading the house brand batteries makes sense. For 21% more money you get 26% more performance.

Why would the house brand take such a different approach? Why not follow the lead of the brand name vendor and place a much higher markup on the premium version?

Assuming that their costs are similar we can assume that they are looking at a very different customer profile. The customer looking at cheaper house brand batteries is likely to be a price sensitive customer. If they were less sensitive to price they would probably be looking at the name brand batteries.

Knowing that it is much less likely that they would be inclined to pay a large premium for a small improvement in performance, and the brand name approach would be a wasted opportunity.

Instead they try and account for the diminishing marginal utility of the extra performance. A price sensitive battery shopper values the utility of a battery, just like a hungry moviegoer appreciates that first mouthful of popcorn.

The price sensitive shopper also places much lower value on the extra utility provided by the premium version, just like the moviegoer gets less enjoyment from the 20th mouthful.

In both cases the solution is to align prices with the value that the customer assigns to the additional units, whether it be mAh or additional mouthfuls of popcorn. Smaller markups on the additional units mean smaller additional profits, but those profits are still additional – profits the house brand vendor would not enjoy if they went with higher markups.